If you’re a business owner, it’s likely you’ve heard your accountant throw out the term GAAP. But what does it mean and why does it matter in the sale of your business?
GAAP stands for Generally Accepted Accounting Principles and is exactly that: a widely-used accounting system requiring businesses to follow the same basic guidelines. Publicly-traded companies are required to follow GAAP in their financial reporting (in addition to standards set forth by the Securities and Exchange Commission), but privately-held companies aren’t held to the same requirements, so making adjustments to your financials to get into GAAP compliance helps the buyer have a clearer understanding of how the financials will look going forward. While business owners often work to reduce their tax liability each year, when it’s time to sell, being able to present financials that comply with GAAP gives buyers higher confidence in your numbers, resulting in a smoother diligence process.
Most businesses we bring to market follow the basic principles of GAAP, with one or two exceptions. However, these seemingly minor deviations from GAAP can complicate the diligence process, delay the sale or affect working capital levels, which can directly impact the cash you receive at closing. We aren’t accountants (and you should consult your accountant for more details on this topic), we have seen firsthand challenges that result from companies not fully GAAP-compliant:
Case Study 1: Lack of PTO Accrual
A few years ago, we sold a successful B2B services company. While the Company had strong financials, a large buyer pool and quickly went under contract, it was discovered in diligence that the Company had never accrued for PTO on the balance sheet, which is required under GAAP.
The Company offered a very generous roll-over option where some employees had accrued hundreds of hours of PTO. The buyer didn’t want to step into a liability where they were responsible for hundreds of excess PTO hours. This was a challenge that had to be worked through on both sides of the transaction to come to a mutually agreeable solution.
Case Study 2: Inaccurate Inventory Costing
In another example, a manufacturing company historically used an accounting system that did not correctly track inventory. When the owner hired a CPA to review the Company’s financials prior to sale, she applied a $1M+ inventory adjustment to the prior 12-months of financial statements to align them with GAAP.
This complex adjustment impacted the Company’s gross margins and EBITDA and stalled the diligence process for three months as both sides had to do deep analysis of the adjustment. Eventually, the buyer acquired the business, but complications and delays could have been avoided if inventory was kept according to GAAP before going to market.
We’ve encountered many situations where non-GAAP compliant accounting negatively impacted the diligence process, legal documentation, valuation of the business or killed the transaction completely.
It is crucial to present clean, easy-to-follow financial statements when you take your company to market. Choosing a knowledgeable CPA to get your books in order now will provide a significant return when it’s time to sell your business.
If you thought this was helpful:
Read “Preparing Your Financial Statements for the Sale of Your Business” if you want to understand the different types of financial reporting (compiled, reviewed, audited) that accountants provide.